Confused by the terms thrown around by your realtor or banker when discussing mortgages? Most first-time homebuyers are.
And even if you’ve diligently done your research, some terms are still sure to throw you.
Here’s an explanation of common mortgage terms to help:
Adjustable Rate Mortgage (ARM) has a fixed rate of interest for a set period of time, usually one, three or five years. During the initial period, the interest rate is lower, and after that period it adjusts based on the market.
The adjustment includes the index rate, which is usually based on the Prime Rate, LIBOR, or Treasury Bill, plus a margin. The margin can vary among lenders.
The rate thereafter adjusts at set intervals. If, for example, you are offered a 5/1 ARM with an initial rate of 3.5% percent and an adjustable rate of LIBOR (the index) + 2.25% percent (the margin), you pay 3.5% for the first 5 years, then LIBOR + 2.25% for the next year. Every year thereafter, your rate will change, based on the LIBOR.
Annual Percentage Rate (APR) is the rate of interest paid to the mortgage lender. The rate can either be fixed or adjustable.
Amortization allocates how your payments are divided between principal and interest as part of a schedule. For example, a typical amortization schedule for a 15-year loan includes the amount borrowed (principal), interest rate paid and term. The result is a monthly breakdown of how much interest you pay and how much is paid on the amount borrowed. This will come in handy when you itemize your taxes.
Appraisal is conducted by a professional appraiser who inspects the property and gives an estimated value based on condition and comparison with houses sold recently. Appraisals are required by lenders to ensure the house is worth the investment.
Closing Costs include attorney fees, recording fees, and other costs you, the buyer, must pay. Closing costs are usually 2 to 5% of the property’s cost, so they can be fairly steep. There are several options to reduce closing costs: You can ask the seller to pay them or you can compare them to standard costs to ensure they’re as low as they should be. Beware of fraudulent or inflated closing costs.
Construction Mortgage is used when you’re building your own home. With a construction mortgage, the lender advances money based on the builder’s construction schedule. When the home is finished, the mortgage converts to a permanent mortgage.
Debt-to-Income Ratio compares the buyer’s monthly expenses, including the mortgage to income. The lender divides the income figure into the expense figure, and the result is a percentage. The higher the percentage, the riskier the loan.
Down Payment is the amount of the purchase price the buyer pays. Most lenders require a 20% down payment, although there are other low down-payment options.
Earnest Money is a deposit you usually give to your realtor to show you’re serious about buying. If you buy the home, the funds go toward your down payment. However, if the deal falls through, you may not be able to reclaim your deposit. Earnest money is usually 1 to 3% of the home’s value.
Equity is the difference between the value of the home and the mortgage loan. As you pay on your mortgage, your equity increases.
Escrow can mean two different accounts. One escrow account is where certain funds, such as earnest money, are held until the closing. After you close on your mortgage, you may also have an ongoing escrow account with the mortgage lender for homeowner’s insurance and property taxes, which are collected as part of your monthly mortgage payments and forwarded to your insurer or taxing authority.
Fixed Rate Mortgage ensures your payment never changes because the interest rate and the term of the loan are set for the life of the loan. The terms of fixed rate mortgages can range from 10 years to up to 40 years.
Good Faith Estimate is an estimate by the lender of the mortgage closing costs. It is not an exact amount, but it gives buyers an idea of how much money they need for closing.
Homeowner’s Insurance must be secured by the buyer before the mortgage closing date. The policy must list the lender as loss payee.
Loan-to-Value Ratio (LTV Ratio) divides the amount of the mortgage by the value of the home. Lenders usually require your LTV ratio to be 80% or lower to qualify for a mortgage.
Origination Fee may include an application fee, appraisal fee, fees for all the follow-up work and other costs associated with the loan and is paid to the lender. This is usually expressed in points. These fees are represented as a lump sum on the Good Faith Estimate, so ask for a breakdown to see what you’re actually being charged. These fees are also negotiable, so make sure you’re not paying more than you should.
Points are percentage points of the loan amount equal to 1% of the total loan. For example, $1,000 is 1 point for a $100,000 loan. To get a lower interest rate, lenders may allow borrowers to “buy down” the rate by paying points. Paying a percentage point up front in order to get a lower rate will save you money if you stay in the house for the duration of the loan. If you move shortly after buying the property, you’ll probably lose money.
Private Mortgage Insurance (PMI) is a monthly premium for those borrowers whose LTV ratio is higher than 80%. PMI covers the lender in case of default until the borrower reaches an 80% LTV ratio. Instead, many people who require PMI take out a second mortgage to use as a down payment on the first.
Settlement Costs include closing costs, prepaid interest, tax and insurance escrow and the down payment.
Title Insurance ensures the property’s title is clear of any liens. A lien is basically the legal right to keep possession of property belonging to another person until a debt owed by that person is discharged and is always recorded by the government. A lien would jeopardize the mortgage, because the lender is using the home as collateral for the mortgage transaction. If someone else has a right to part of that, the lender could lose money.
Truth in Lending regulations including proper disclosure of rates, how to advertise mortgage loans and many other aspects of the lending process. These regulations were put into place to protect consumers.
Did you know?
Did you know community banks traditionally have lower rates and closing costs than national banks? Check out our rates here.
To learn more, and to find out why residents of Celina, Ft. Recovery, and Greenville have been choosing Mercer Savings Bank for mortgage loans for more than 125 years, contact us today.